Why China Lags Behind the U.S. in Shale Gas Development

China has a strong will to develop shale gas but lags behind the USA

This post is part I of a series on China vs. USA Shale Gas Development

In the new shale gas revolution, the United States has taken the lead in exploration, development, technology, production, and even the export of shale gas. The U.S. is indisputably the best in this field and best practices from the U.S. will only help other countries develop their own shale gas industries.

China, a country with the world’s highest shale gas reserves, is attempting to exponentially build its shale gas capacity in hopes that they too can achieve energy security and influence in the world’s gas pricing regimes.

Are China’s shale gas plans too optimistic? This article will compare the U.S. regulatory environment to see how far behind China is from the U.S. in developing its nascent shale gas industry.

U.S. vs. China Regulatory Environment

United States

When looking at the United States’ regulatory environment, one needs to divide the analysis into three parts.

Federal laws

State laws

Political stances of the government

In terms of Federal Laws, the U.S. has long-established environmental guidelines that regulate the oil and gas industries. These laws yield to state laws and are difficult for federal agencies to enforce. As a result, federal agencies play a very small role in regulating extraction industries, despite the greater concern for the environment in the U.S. than in China. Instead, this role falls to State Agencies.

At the state level, regulations governing the shale industry vary widely depending on the political attitudes toward the extraction industry. Texas, for example, is anti- federal state regulation and the approval of drilling permits is generally lax where no environmental review is required for a proposed project. New York, on the other hand, requires a comprehensive review of the environmental impacts, an application for drilling, and a drilling work plan. These state regulations, however, can easily be disregarded or enforced depending on the national political leadership at the time.

Dick Cheney spurred the development of the American shale industry through his Energy Policy Act of 2005

Since Cheney’s time, however, the political mood toward the shale industry has soured with concerns over shale’s potential for polluting water sources and creating earthquakes. Obama’s administration, for instance, will be implementing stricter controls over drillers by requiring them to “capture emissions of certain air pollutants from new wells” starting in 2015.

As such, the combination of lax federal enforcement, varied state laws, and the political support created by Cheney’s time in office was particularly conducive toward enticing developers into the industry. The relaxed environmental regulatory system brought down the risks and justified bringing in investment, technology, and human capital for small and large firms alike. As such, these policies opened the way for competition and spurred technological improvements to hydraulic fracking.

China

In contrast to the U.S., the monitoring of shale gas is difficult in China due to the fact that the central government does not yet have a set regulatory environment. As such, understanding which of China’s government policies will impact the shale industry will be half based on regulations for other extractive fuels and half on the current government’s directives for shale gas.

In trying to understand which policies will most likely impact shale gas, one needs to first look at the policies currently in place for other non-traditional extractive industries such as coal-based methane. If shale were to be controlled under the same policies, companies operating in China’s shale gas industries could potentially take advantage of its status as an “independent mineral” (approved December 31, 2011), as it opens shale “exploration to more participants.”

Independent mineral status encourages the exploration of shale gas by foreign companies and induces competition via “certain tax and administrative benefits.” In terms of environmental regulations, China’s control of land, water, and air are varied and controlled by different ministries. The impact of these policies will have to wait on a more firm classification of shale gas by the government.

China’s previous Politburo, it remains to be seen what the directives of the new Politburo are

The national political climate for shale gas is seemingly positive as well, due to the National People’s Congress’s directive for shale gas as an important resource for China’s national energy security. As such, under the 12th Five Year Plan (2011-2015), China has put in place plans for the “assessment for shale and confirming the current reserve estimates“. A National Shale Gas Development Program has also been established during this period, where the government has placed an emphasis on R&D for technology, exploration, and development of shale gas for the 13th Five Year Plan (2016-2020). However, in late 2012, China oversaw the change of a new President, Xi Jinping, and his new politburo. It remains to be seen what this group of influence government officials will do for the shale gas industry.

Why is China’s Shale Gas Industry Lagging?

Regulatory Structure

The U.S. success with shale gas is a product of the clear boundaries in federal and state regulations, and the conducive nature of Cheney’s 2005 Energy Policy Act. These factors allowed for small and big energy firms to have equal opportunity in leasing or acquiring land, sell gas in a competitive natural gas pricing regime, and understand the environmental boundaries that they have to operate in. This transparent regulatory regime made it easy for investors to understand the risks and actively invest in new shale basins, which in turn helped smaller energy firms hone their technology in hydraulic fracking.

Once smaller firms succeeded, the shale industry saw a large flux of mergers of smaller firms with larger conglomerates, which brought in much more investment, infrastructure, and human capital. This timeline helped shale develop exponentially as the industry never saw a relaxation in funding or technological know-how.

China, on the other hand, is lagging due to the very nature of its current regulatory structure with shale gas. As previously stated, the central government’s endorsement of shale gas is particularly strong. However, due to the importance of shale gas in China’s future energy security plans, a failure of this industry could be extremely embarrassing for the Chinese Communist Party. As such, current directives have shown to be vague and inconsistent. This environment is in direct contrast to the American context as it creates a cloud of uncertainty for companies and overseas investors.

Barriers to Entry

Moreover, the barriers for entry for small and large firms into the American shale gas industry were much lower as individual companies were able to lease or acquire land to explore on their own accord. They were only required to submit paperwork to the state government. In China, however, the central government tightly controls shale gas blocks by organizing auctions or granting exploration rights. In the first auction, held in June 2011, only state-owned companies were allowed to compete. This auction elicited a weak response as only six companies put in bids for four blocks and only 2 blocks were awarded in the end. A second auction was finally put up in October 2012, and was deemed slightly more successful as it garnered 152 bids for 20 blocks.

Nonetheless, barriers were still high as entities had to be either Chinese companies or Chinese held joint-ventured companies. To make matters more unequal there was also a clear absence of bids from China’s top oil and natural gas companies from the 152 bids received as their vote would’ve proven redundant since they already have rights to exploration on certain blocks. This does not yet mention the minimum value the company needs to have ($48 million USD) or the minimum they are required to invest into the blocks for the next three years.

Shale Gas Extraction Site in Sichuan Province, China

Profit Disincentives

Profit incentives are also much lower in China as the status of shale gas as an “independent mining resource” is precarious. Natural gas is generally state controlled, meaning that companies do not have control over the pricing of gas, no matter how little or much they produced. This is a strong disincentive to companies looking to enter the industry as natural gas is priced below the market in China.

In the U.S., on the other hand, companies had complete control over the pricing of the output of gas and even the export of it. Since the status of shale gas has changed since the end of 2011, stakeholders will continue to doubt the nature of shale gas’s profitability until they see how the pricing of shale gas is treated once production is stronger.

Lastly, the uncertainty of environmental policies will prove to be a disadvantage to investments and entry into China’s shale gas industries. In the U.S., when energy companies were beginning to explore and produce shale, they knew that they had to observe at a minimum federal regulations that dealt with emissions, the treatment of water, and the land. Although companies were ultimately not required to observe these regulations due to the 2005 Energy Policy Act, there were concrete lines that allowed them to make risk assessments for the future. China, on the other hand, there is no such minimum line in which they can refer to. Stakeholders cannot reasonably assume that shale gas’s environmental regulation will be similar to coal-based methane, natural gas, oil, or coal. As such, any type of risk analysis or cost-benefit analysis will be inaccurate. To make matters worse, the lack of environmental guidelines could cost stakeholders more over time as any reversal in policy could prove to be detrimental and costly to accommodate.

What other differences are there?

The American shale gas industry took over 20 years to develop into the global leader it is today due to favorable political support, a concrete regulatory environment, and low barriers to entry. This policy environment resulted in creating competition, advancing technological development, and spurring on innovation. China, on the other hand, has the political support but lacks a reliable regulatory environment and holds one of the highest barriers to entry into the shale industry.

These differences are clear, explaining the standstill the Chinese shale industry has experienced in the last few years. But what other differences are there between these two superpowers?

In the next post I will explore the infrastructural capacity gap between the USA and China, subscribe now to get more on this topic and more at EnergyInAsia.

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§ 2 Responses to Why China Lags Behind the U.S. in Shale Gas Development

Great insight to the many issues facing the shale developments in China. I also think the smaller independent operators in the US have given the shale boom in the US the critical mass it needed to thrive. They can change plans quickly to accommodate market forces. It will be hard to get that in China with so much oversight, specific planning and aversion to risk.